Understanding The Various Types Of Funding
Starting a business can be a huge challenge, from creating a business plan to developing a marketing strategy, it can all be overwhelming for a new startup. One of the major challenges of starting a new business venture is arranging capital. While in today’s day and age, funding for startups is easily available, one has to be aware and understand the various methods a start-up can raise funding. A successful business always has strong roots and a financially stable background, which in turn helps the company grow and evolve in the long run.
The initial capital which any new startup raises should be carefully procured with proper due diligence and must be utilized optimally. We at Financial Education believe that having information about every available funding method is crucial to succeed as an entrepreneur. In this article, we shall discuss and explain the various ways a start-up can avail funding and use it efficiently. Each way of raising capital has its own merits and demerits, and we shall go over everything, giving you a holistic view of the various methods of funding. So let’s get started!
Why do Start-Up’s Need Funding?
Now, one may ask why does a start-up needs funding? Why don’t the owners put in their own capital and run the business? Well, in today’s world, an innovative and attractive business idea is not enough to create a successful venture. One has to develop a proper plan for arranging finances and managing them properly. Growth and development require money, and scaling up your startup requires large capital which has to be procured from somewhere. A lack of capital can hinder the growth and development of any small business.
Getting additional capital and being funded by investors not only gives a small business the potential to grow, but the investors can offer valuable guidance and create connections for you, which in turn will always benefit the organization. Another benefit of having adequate capital is that you can hire talented professionals who can give in their inputs and help you take your business to whole new heights. Founder of Financial Education, Jeremy Lefebvre believes that with growth comes new opportunities, and for growth you need money. So, funding for a startup is like fuel, which gives them the power and potential to reach new heights of success.
The Various Types of Funding
The financial universe offers a vast range of options to new businesses and startups for arranging capital. From angel investors, venture capitalists to equity financing, there are several ways one can arrange funds. Each way differs from one another and has its own advantage and disadvantage. So, let’s discuss the various types of funding a startup can avail.
1. Angel Investors
Angel investors are private investors who provide financial assistance and backing to small startups and entrepreneurs. Angel investors are generally high net worth individuals who are looking to deploy their wealth in attractive and high potential business, which can later provide them great value for their investment. The funds that the angel investor provides helps a startup kick start their operations and gets the business on its feet.
Angel investors provide small businesses and startups the initial seed fund to start their journey, and they provide the money in return for ownership equity or convertible debt. Angel investors can be a great way for any new business to arrange capital as they are an attractive and appealing source of funding.
Advantages of Raising Capital via Angel Investors
Easy to Approach and Take Risk: The first benefit of raising capital from angel investors is that they can be found easily and generally invest from their own pockets. Hence there is always room for negotiation. They can understand your business and are usually willing to take risks. Overall arranging finance from angel investors is easy when compared to other methods of financing.
No Interest or Repayment: Another benefit of arranging finance from angel investors is that you don’t have to pay any interest on the capital raised, nor do you have to repay back the investment. Angel investors understand the risk they take when investing in your startup. Your idea and business plan should be attractive, and any startup can get funded by angel investors. What they get in return for the investment is that if your venture becomes successful, they grow and earn with you.
Angel Investors offer Much more than just Capital: Angel investors are usually wealthy and well-connected people with years of experience. We at Financial Education believe that apart from the financing, they can offer valuable advice and guidance which can help you grow your business and take it to the next level.
Disadvantages of Raising Capital via Angel Investors
Increased Pressure and High Expectations: When an angel investor invests in your business, they expect it to grow and rise, which puts additional pressure on the people managing the business. The reason angel investors invest in startups is to see their investments rise and generate returns. So there is always a sense of pressure and expectations from the business which can be pretty intense sometimes.
Dilution of Ownership and Control of the Business: With investments from an angel investor, they also take active control in the management and decision-making of the company, which means that the owners will lose partial control over the business. This is something that one has to accept when receiving capital from angel investors.
Limited chances of Follow-up Investment: Another drawback of angel investors is that once they make their initial investment in your company, it is very unlikely that they will agree to another round of funding. Generally, angel investors will not provide additional capital until and unless the company is showing great signs of growth.
2. Venture Capital
Venture capital is a form of funding that is provided to small businesses and startups from investment banks and financial institutions. Capital is provided to new and rising businesses that have great growth potential and a bright future. This type of funding can be provided at various stages of a business. Venture capitalists often take risks and invest in high-potential companies, with expectations to generate great returns as the company grows.
These financial institutions are often partnerships where partners invest and the pooled fund is then invested in high-potential companies. Promising and attractive businesses can avail funding from venture capitalists and it is a great way of arranging capital.
Advantages of Raising Funds via Venture Capital
Large Capital can be Raised: We at Financial Education believe that the benefit of raising funds from venture capital is that they offer funding starting from a hundred thousand dollars which can go up to even twenty or twenty-five million dollars. So an emerging business can avail large amounts of capital which can help in growth and development.
Opportunity to Collaborate and Expand the Business: Another benefit of raising funds from venture capital is that they offer various opportunities to growing business and can also help you collaborate with similar startups which can lead to great potential for your business. As venture capitals have vast networks and connections, you can benefit from this and take advantage.
Guidance and Assistance at every Stage & Future Funding: When raising funds from venture capital, they not only provide the money but also offer assistance and guidance with creating business plans, hiring professional teams, and overall can help you grow the company. And along with all this, there is always the potential to raise funds in the future as they can introduce you to various other channels of finance.
Disadvantages of Raising Funds via Venture Capital
Lengthy and slow process of availing funds: Usually, when the owner of a new company approaches any VC, they inspect his background, finances, and record. Along with that, they require a solid & in-depth business plan and details regarding the future prospect of the company. And after all the due diligence, a lot of meetings take place which in turn leads to delay in the actual investment.
Part by part release of funds: Generally, when a VC invests in a startup, they do not release the funds altogether. Instead, funds are released in a step-by-step process, which can be a bit challenging for a new business as sometimes they may require large amounts of funds together.
A Member of the VC is placed in your business: Whenever you avail funding from venture capital, they place a member of their team in your business, which can interfere with your management and affect the overall control of the business.
3. Equity Financing and Convertible Debt Financing
Equity financing and convertible debt financing is another great way for small businesses and startups to raise capital. As availing loans and determining the valuation of a new business is very difficult, what is usually done is that investors or financial institutions invest in the new business and their investment will, later on, convert into equity ownership and stake in the company. They invest in new startups for a stake and equity ownership in the company in the later stages of its growth and life.
This way of arranging finance is great for new businesses as they usually don’t have a credit history and it is very difficult to have valuations of their company. So equity financing is a great way to get capital initially without any debt and stress of repayment.
Advantages of Equity Financing and Convertible Debt Financing
Ease of Raising Capital: Equity financing is great for new companies as they don’t have to have great credit records and nor do they have to pay interest on the capital raised. It is an effective and easy way of raising capital for a new business.
No Burden and Stress of Repayment: Another benefit of raising capital via equity financing is that there is no burden and pressure of repayment and paying regular interest. This allows proper and efficient use of generated revenue and is great for a new business.
Trustworthy and Efficient: Funding from equity financing is a trustworthy and efficient way of raising capital as the company will receive all the amount together, and they also offer valuable advice which can lead to the growth and development of the business. This method of raising funds is reliable and trustworthy.
Disadvantages of Equity Financing and Convertible Debt Financing
Dilution of Profits and Ownership: When you receive investments from equity financing, you have to give up a share of profits and partial control over the business. This is a trade-off for not having to pay interest and raising debt-free capital.
Long and Complicated Process: Availing funds from equity financing can be a long and complicated process as it involves diluting the company’s ownership and equity holdings. Overall it is a tedious and long process.
High Expectations and Chances of Conflict: As the money raised is debt-free, there is a high expectation from the business to perform well. And with control over the management of the company, oftentimes there can be conflicts between the investors and owner, which is not good for the health of a company.
Crowdfunding is another way new businesses and startups can avail funding. This method of funding involves raising capital through various different sources. The sources can include general investors, family & friends, customers, angel investors, banks, and even venture capitals. The collective and combined method of raising capital from all these sources is called crowdfunding.
Crowdfunding can also be done via crowdfunding platforms which can help raise capital for the business. This pool of money is then used for the development and growth of the business. One has to have a large network of connections and contacts to generate capital via this method. Sites such as Kickstarter and IndieGoGo are some great places to start crowdfunding.
Advantages of raising capital via Crowdfunding
Quick and Cost-Efficient: Raising capital through crowdfunding can be a quick and cost-efficient way to raise finance as there is no major expense required. And people from various backgrounds can invest in your business.
Great way to see Public Sentiment: Crowdfunding is a great way to check out the public sentiment towards your company. If the general public tends to invest largely in your business, then you are on the right track and your company is on the way to success.
Unique Ideas can be funded through Crowdfunding: Another benefit of raising capital through crowdfunding is that ideas that may not appeal to banks and institutions can be funded through crowdfunding as you can explain your business plan and idea to a large and vast array of people.
Disadvantages of funding via Crowdfunding
Crowdfunding is a challenging approach: Crowdfunding is a difficult and challenging way to raise capital. As not each and every project that applies to raise finance via this method is accepted and invested in by the public.
Time-consuming and Detailed Procedure: Oftentimes, applying and getting started on a crowdfunding site requires a lot of verification and documentation which can take up time and is a slow and lengthy process.
Risk of Reputation Damage: Another disadvantage of raising funds through crowdfunding is that if the required capital is not raised, the public may form an image of the company as an unsuccessful venture and may hinder the growth of the business.
Another way to raise capital for small businesses and startups is to avail loans or debt. There are various organizations, banks, and financial institutions that offer loans to new and promising companies. While this way of raising capital involves paying interest on the borrowed amount, it ensures complete ownership and management is retained. The money lent by the organization is given on interest and is to be returned in a certain time period.
Availing a loan is a process that requires you to propose your business plan to the lending institution and after their proper due diligence, they may sanction the required amount. People with good credit records and stable financial backgrounds can avail this method of raising capital.
Types of Loans
- Small Business Loan – This is a type of loan that is given and backed by the “Small Business Administration” or also known as SBA. It is a government program that supports and finances small businesses and startups.
- Short Term Loans – These Loans are given for a short amount of time which can range from two months to twenty-four months.
- Loans from Friends & family – A new business or startup can avail loans from their friends or family who are capable and in a position to lend money.
- Credit Card Loans – Small businesses and startups can also avail Credit card loans provided that their credit history is good. This method is relatively easy and quick.
- Personal Loans – The business owner can also take up a loan on his personal account and pledge some security or collateral for the amount being sanctioned.
Advantages of raising capital via Loans
Low-interest rates: Loans can often be taken at low-interest rates which makes it easy for the new business to pay back the installments. If the credit history of the borrower is good, then loans can be procured at attractive interest rates.
Flexibility of Use: After the business acquires the loan, they are free to utilize the money as per their preferences and requirements. There is no authority looking over their finances and spending, which gives freedom to work.
Full Ownership and Control of Business: Another advantage of raising capital via loans is that the owner retains full ownership and can manage and run the company accordingly. There is no dilution of ownership and nor is there any interference in the management.
Disadvantages of Raising Capital via Loans
Requirement of Collateral: Whenever a business or startup takes a loan, they have to provide collateral or security for the borrowed amount for cases of default and non-payment. This can be a hurdle for new and small businesses.
Interest and Repayment: Another disadvantage of raising capital via loans is the constant paying of interest and repayment of the loan amount. This cuts into the profits and leads to additional pressure and stress on the business.
How to Optimally Use the Capital You Raise?
After raising capital for your business or startup, the most crucial thing is to use and deploy it efficiently. Founder of Financial Education, Jeremy Lefebvre believes that the success of your business depends on how efficiently you use the raised capital. Some tips that you can follow are to always have a business plan laid out in advance. This shall ensure that you use the funds in a proper manner and avoid overspending. Always maintain proper documentation and record all your transactions. Try and avoid spending on unnecessary things as this will ensure you are left with sufficient capital for your business and the entire process proceeds smoothly.
While each and every method of raising capital has its own merits and demerits, you have to select the funding source which suits your business the most and meets all your demands. Each business and startup is different in nature and so are their requirements. So, ensure you properly analyze all the various funding methods and choose the one which suits your requirements the most and can be availed in the smoothest and simplest manner.
Now, with all this knowledge, you are ready to start your new business and proceed with arranging capital in the most efficient manner. Creating and starting a new business can be challenging and difficult in the beginning, but with passion and determination, you can easily achieve what you desire. Always have a proper plan and vision for your business beforehand and aim in the direction that you wish to take your company. So, go ahead and explore the various funding methods that you can avail for your business and start your journey. If you liked this article, make sure to visit Jeremy Lefebvre’s YouTube channel “Financial Education” for more informative content!